India should borrow overseas in Re, not $

The Finance Minister in her Budget speech last week touched upon the possibility of the government raising debt from overseas investors via an international debt issuance.

In the context of the country’s liquidity and credit situation, there could not be a better time to take this route. With the demise of IL&FS in the third quarter 2018, and the massive collateral damage to the domestic credit markets — vulnerability of large balance sheets has been exposed to extremely constrained liquidity channels.

This has led to the circumstances fast leading to the apparent liquidity crisis, transforming into a credit crisis.

A quick glance at the fast widening credit spreads for high yield Indian bonds, and the absence of a viable capital market route for most NBFCs through the first two quarters of 2019 compounded matters. Hence, after the ECB rules were revised in January 2019, borrowers have been scurrying to raise offshore debt.

However, since the guidelines of January 2019, less than $1.6 billion has been raised from offshore Investors — almost six months post this relaxation, which is a drop in the ocean.

The domestic capital markets are expected to support a $275-$300 billion issuance through FY 2020 as per current estimates. Of this the Budget estimates are for $105 billion of government bonds, approximately $65 billion of State government borrowings and circa $110 billion of Corporate India’s capital market dependence.

Corporate options

Corporate India needs rupees and will be happy to stay away from needless introduction of currency risks in their book.

Hence the natural preference to borrow through the rupee-denominated offshore borrowing format (announced with such fanfare by PM Modi in 2015 as Masala Bonds in his address at the Wembley arena in London).

So how do we encourage the international lender to lend in rupees?

The lenders in question, mostly large asset managers and international emerging market funds, almost unanimously complain of the lack of liquidity and availability of appropriate benchmarks when it comes to attempt to price and trade Indian corporate credit in the international markets. They also complain on the lack of an “established yield curve” on Indian bonds, particularly rupee bonds.

The introduction of an Indian Sovereign Bond Issuance in rupees thereby mitigates quite a few significant Investor concerns. One would expect a $3 billion — 5year/7year/10year issuance in rupee denominated government issued masala bonds (say $1 billion per tranche) as one of the methods of accessing the international capital markets. At present levels, one would expect the same to be priced in the 6.50-6.75 per cent range in rupee coupon terms.

The availability of a liquid tradable rupee sovereign yield curve in euro-clearable bonds and the utilisation of this offshore Sovereign Bond rupee (or Masala curve) will enable corporate India to follow suit. The opening up of this liquidity channel, reduces the pressure on the domestic credit markets and imparting much needed liquidity, particularly to the NBFC channel which really needs rupee liquidity and not introduction to currency risk via dollar borrowings.

Not cheaper to borrow in dollar

One of our biggest misconceptions on borrowing is that dollar borrowing costs are lower than rupee borrowing costs. The fallacy is in confusing “Coupon” with “Cost”, assuming incorrectly parity between dollar and rupee coupons and costs.

Whereas, it is indeed true that the coupon or interest payable in dollars to investors will be lower for dollar borrowings, it is imperative to look at the this as “swapped to rupee” to compare effectively against the cost of a potential rupee issuance. Hence that 3.25-3.50 per cent actually may “swap to” an approximate 8.0-8.50 per cent rupee or so.. Not only is it “cheaper” to raise rupees but the massive attendant benefits of opening up the international pool of fixed income capital in rupee denomination for various domestic issuers must be the icing on the cake.

So Finance Minister Sitharaman has done well to make the announcement in this regard. It is important that the approach towards the international fixed income markets is a calibrated one — in the most desired currency and at the “cheapest effective costs”.

The writer is Director and Head - Investments Sun Global Investments. The views expressed are personal